Hindsight Bias – Did you know it already?

Hindsight bias is a behavioral trait in many of us. It is a sense that you knew a particular incident would happen after it has happened. You feel that you had predicted the incident. It may not be accurate as you might have thought of different outcomes but once a particular outcome takes place, you tend to remember that one and forget the other possible outcomes.

This trait can lead to overconfidence and inaccurate estimation of events and their probabilities.

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Common examples of hindsight bias –

If you see clouds getting thick and grey, you might think different things – ‘it might rain’, ‘it will rain’ or ‘the cloud cover will pass on’. But if it rains sometime later, you will believe that you knew it will rain.

It is the finals of the IPL tournament and your favourite team is playing. If it is an equally contested match, you will think of different possibilities – ‘Your team wins’, ‘Your team loses’, ‘It can end up being a draw due to rains’. But if your team wins, you will feel that you predicted correctly that they will win.

Similarly, you buy a stock and the price falls, you think that you just knew it that it would fall. On the other hand, if you make handsome profits, you will feel proud that you made such an awesome decision.

And everyone knew that who will win the elections 🙂

Impact of Hindsight Bias on your Investments

It can lead to overconfidence in our investment skills. If we pick some stocks or purchase some mutual fund schemes and they perform well, we believe that we have excellent investment skills. We only remember the instances when we were right and overlook the times when we were wrong. It might be that the factors that allowed us to predict correctly made the decision easy or obvious. This might lead to irrational and risky investment behaviour.

Look only for expected outcomes –

We tend to look for expected outcomes in any decision/action we take. We tend to remember only the big unexpected events. This results in not planning for the unexpected events. If we do not remember smaller events that affected our portfolio, we may not be managing the portfolio in the best manner. It is not possible to think of all possible outcomes but we have to be ready for unexpected outcomes. Believing that unpredictability is the norm will not have too many nasty surprises.

Mistaken analysis –

We tend to use memory rather than data and other factors to evaluate past decisions. This is a trap. It clouds our decision making. We remember the times our predictions were right and ignore the wrong ones. This can lead to irrational decisions regarding our finances.

Another mistake form of decision making is that if an event happens, we tend to look back and look for signs and pointers that proved that the event will happen. In hindsight, this might be easy, but at that time, there were many other factors and signs which would have made it difficult to predict.

How can we avoid hindsight bias –

Learn from the past –

We should learn from past mistakes – our mistakes made in the investment world. For example, when the technology bubble was busted in 1998, a lot of people said, ‘I knew it’ but very few of them had forecasted it. It is not easy to predict different scenarios. But we can learn from past performance of investment assets, market behaviour and our behaviour and decision making. Rather than focusing only on the right decisions, one should objectively evaluate all investment decisions – right and wrong.

Be aware of the influence of hindsight bias –

A majority of us have a hindsight bias. It is best to acknowledge it and then work around it so that we do not make wrong investment decisions. For example, if you have decided to buy a stock, do not look for reports and news articles that support your decision (this is confirmation bias). Search for reasons or news items that go into the decision. This will help in a more holistic investment decision.

Plan for the unexpected –

Expect the unexpected. Hope for the best but plan for the worst. We should hedge against negative events. It is a good idea to diversify the investment portfolio so that it is protected against unexpected negative outcomes. Focus on proper Asset Allocation.

Avoid being overconfident –

We tend to become overconfident when we feel that we have predicted events correctly. We follow the same pattern of decision making and somewhere down the line, we lose money. It is better to have a realistic view of our strengths and limitations. Look for performance indicators while making investment decisions. This helps in managing risk better and building a suitable investment portfolio.

Decide rationally –

Do your research thoroughly, understand the pros and cons of all investment decisions and actions and then choose the most appropriate one in your current situation rather than being swayed by past predictions.

Hindsight bias is a behavioral trait that can lead to problems in your investment portfolio. No one can be right all the time or wrong all the time. Objective evaluation is the best way to avoid such biases and make rational investment decisions.

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Hemant Beniwal is a CERTIFIED FINANCIAL PLANNER and his Company Ark Primary Advisors Pvt Ltd is registered as an Investment Adviser with SEBI. Hemant is also a member of the Financial Planning Association, U.S.A and registered as a life planner with Kinder Institute of Life Planning, U.S.A.
He started his Financial Planning Practice & TFL Guide Blog in 2009. "The Financial Literates" is a dream & mission to make Indians Financial Literate.

Dear Hemant, My mother used to say,”You will never save,from what is leftover. My father would always write each and every expense ,making it difficult for mother even to tally for the account ,family lived on very limited resources. In spite all these , when we opened her box after her 13th day ceremony , she had enough for her yearlong rituals. Every thing we do is important ,but most important is first priority.

My Father had always said that ” don’t do something because your friend or colleague is doing- it could be a purchase of an item, investment in a share or MF,”. Follow your own intuition and test it with normal rules of saving and investment.” I have found this to be very useful- avoiding the ” Herd Mentality ” always helps.

Joyce Meyer says- 1.Work for it. 2. Give generously. The best way to be happy in this life is to be a blessing to other people. That’s true of how we spend our time and certainly true of how we spend our money. 3. Save. Start with whatever you can afford and save more as you’re able. 4. Spend. Here’s the good part! Yes, you need to spend some of your money. Just make sure that when you’re spending, you’re following a few, simple guidelines: Know what you have. Make sure that you’re balancing your checkbook and have a budget prepared so that you know what is coming in and what’s going out. * Don’t buy what you don’t need. The quickest way to the prison of debt is convincing ourselves that “wants” are “needs.” If you obviously don’t need something and it’s not in your budget to afford it, then be bold enough not to buy it.

* Don’t buy with what you don’t have. Credit cards aren’t bad in and of themselves, but if you can’t control what you spend with them, then using them is a bad idea. A general rule for using credit cards is to only spend what you can pay off at the end of the month. The interest on consumer debt can quickly get out of control.

* Pay debts off immediately. Living debt-free will give you the flexibility to live more generously and more abundantly. If you’re dealing with debt now, make a plan to get out. Start with the smallest debt and work your way to the biggest ones.

* Invest. This is wise spending. It’s setting aside money so that it will bring a return later on. Sound investments in property, mutual funds and the like can allow your money to work for you instead of the other way around.

Figuring out the best options for your financial future can seem overwhelming with all the choices out there. And what works for one person may not be what works for you. That’s why I recommend talking with a financial advisor.

Past performances Do Not guarantee future successes…. Get the latest pieces of information to make a correct decision, and …Do Admit & Accept… that you’re responsible if things turned out well or badly…